The loonie soars

It's been a good year for the loonie. In the midst of a severe global recession, the Canadian dollar has turned in a strong performance, although that performance certainly hasn't been slow and steady.

As of November 12, the Canadian dollar has gained fully 16.1% against the U.S. dollar this year. It has gained ground against many other currencies as well, appreciating by 8.2% versus the euro, 9.9% against the Swiss franc and 14.5% against the Japanese yen.

But it certainly was a wild ride. The loonie started 2009 at 81.84 cents U.S. After dipping as low as 76.59 cents U.S. in March, it has climbed steadily, reaching a peak of 97.19 cents U.S. in mid-October. Although it's difficult to predict currency movements with 100% accuracy, most analysts expect the loonie to end the year close to 95 cents U.S., before advancing to parity and beyond in 2010.

What are the reasons behind the loonie's recent rise? And why has our dollar gone up so fast? There are several reasons:

Demand for commoditiesTo its residents, Canada's economy is well-diversified. In the eyes of the rest of the world, however, our economy is still dominated by the production of several basic commodities: precious metals (gold and silver), industrial minerals (zinc, nickel, lead, aluminum, etc.), coal, wheat, potash, lumber and, increasingly, oil and gas (see below). As the world economy gradually recovers, companies will need more of what Canada is selling. The anticipation of this demand is driving the loonie higher in the short term.

Oil and gasThe development of Canada's oil and gas industry over the past decade has given a big boost to the loonie. Alberta's oil sands are among the largest oil fields in the world; this makes them exceptionally attractive to both Canadian and foreign oil companies. As these companies sell their oil, they get paid in U.S. dollars. But when they invest in oil sands properties and employ Canadian workers, they exchange those U.S. dollars for loonies to pay their bills. This constant and increasing demand for Canadian dollars drives the value of the loonie higher.

Relative fiscal strengthThere's no doubt about it: the recent recession has been hard on Canada. But compared to many other industrialized countries, Canada has made it through relatively well. Many of the problems at the heart of the current economic malaise—a speculative housing bubble, unsound lending practices by banks, heavily indebted consumers—were never really problems in Canada or, if they were, they were much smaller in scale. This has, in turn, diminished the need for government bailouts and other stimuli, which should allow our economy to return to "normal" more quickly than other industrialized nations. Such relative fiscal strength has been good news for the loonie.

Mess in the U.S.A good part of the loonie's recent rise can be attributed to the general weakness of the U.S. currency. The reasons for this weakness are easily understood: as of August 1, the U.S. government's year-to-date fiscal deficit totalled $1.3 trillion. By 2019, the U.S. federal debt is estimated to be $23.2 trillion, or 100% of U.S. GDP. As traders and analysts become more pessimistic about the U.S. fiscal situation, they move their investments out of the U.S. market, and their savings out of U.S. dollars and into other currencies which they consider safer. One of the beneficiaries of this movement is our loonie.

While a strong dollar may make Canadians proud, it often makes economists and stock market investors concerned. A stronger currency makes life exceptionally difficult for Canadian manufacturers and exporters; the cost of Canadian goods is that much higher abroad, making it more difficult for Canadian producers to compete. At a time of financial and economic crisis, this is the last thing that the country's struggling manufacturers and exporters want to hear.

For individuals, however, a rising loonie can be a good thing. For snowbirds in particular, an appreciating Canadian dollar can be an excellent opportunity to save. Here are some ideas regarding how you can put the stronger loonie to work for you:

TravelThe rising loonie is good news for anyone travelling south of the border; the cost of airfare, accommodation, and package or group travel is likely to be much more affordable than in years past. Car rentals, restaurant meals and admission fees to many tourist destinations have also come down in price.

VehiclesFor years, prohibitive exchange rates made it unaffordable to purchase a vehicle in the U.S. and import it into Canada. With the Canadian dollar rapidly approaching parity, that dynamic is changing. Keep in mind, however, that there are several restrictions and requirements on importing vehicles from the U.S. (you must change the dashboard to display speed in kilometres, for example). Check with your province's motor vehicle branch before you buy.

Shopping in the U.S.Cross-border shopping has always been popular with Canadians; a stronger dollar makes it even more so. In addition to clothing, electronics and other items, it can make sense to shop for groceries and packaged goods. Shopping for services (auto repairs, for example) can also be a good idea.

Protecting your portfolioFor investors, the soaring loonie is something of a mixed blessing. While the strong Canadian dollar can buy more shares of U.S. and international companies than it used to, much of a stock's gains can evaporate if the Canadian dollar appreciates faster than your investment. What can investors do about this problem? There are several options.

Currency tradingSophisticated investors may be able to hedge their exposure to a rising loonie by trading currency futures on an exchange. But be cautious: this is a complex strategy best suited to investors with large portfolios and a strong stomach for volatility.

Specialty fundsSeveral specialty mutual funds and exchange-traded funds invest directly in international currencies. Through one of them, it's possible to offset currency movements in other portions of your portfolio. For example, a currency fund that profits from upward movement of the Canadian dollar could offset U.S. stocks that decline in value as the American dollar falls.

Strategic investingAs the Canadian dollar rises against world currencies, some sectors of our economy will likely suffer (manufacturing and exporting), while others will likely benefit (financial services). By overweighting assets that are expected to benefit from a rising dollar, you can profit from the Canadian dollar's rise while offsetting losses in other assets.

Currency-hedging mutual fundsPerhaps the easiest way to protect yourself against currency movements is to invest in a mutual fund that hedges currency exposure in order to stabilize fund performance. Keep in mind that while the demand for such hedging is growing, not all funds offer it. You'll want to talk to your financial professional and read a fund's prospectus to find out exactly how your fund deals with the issue of currency.

Movements in the currency markets are notoriously unpredictable, and the vast majority of Canadians shouldn't base investing decisions on them. Instead of worrying about what will happen to the dollar in the coming months, concentrate on sticking to your long-term financial plan and making sound investment decisions. In the long run, that's the kind of advice that will keep your finances on track no matter what happens to the loonie.